The USA Mortgage

New York City-- On Tuesday, I endorsed a 4% federally guaranteed mortgage to finally give some government aid to homeowners instead of Wall Street and, at the same time, pave the way for household economic security for many years.  For the last few days, Senate Minority Leader Mitch McConnell and the Republican leadership have been calling for a similar plan.  The McConnell variant expands on an earlier, more limited plan proposed by Glenn Hubbard.  The latest version that would benefit all homeowners and indeed all Americans--in line with my proposal--is far larger.  So what do I think about the Republican leadership supporting this idea? 

Very simple.  The Obama Administration and Congressional Democrats should take the Republican support and run with it.

It is, in all likelihood, too late to include a 4% mortgage in the stimulus bill--McConnell's proposal--that could pass as soon as today.  However, if it's a good idea today, it will be a good idea on Monday when the Treasury Department announces its plan to reform the financial sector and address the housing crisis that started the meltdown.  And it will be a good idea, later this month, once this is all debated, when Congress passes legislation to address the financial and housing crises.  It is arguably amazing that Republicans are supporting a 4% mortgage, and the chance for bipartisan action should not be wasted.  If the Obama Administration can pass this proposal into law, it will be one of the best things to happen to the middle class in decades.

Why is this such a good idea?

It is a good idea, first because homeownership remains central to the American Dream.  Notwithstanding the bad rap that homeownership has gotten as a result of confusing, bait and switch mortgages offered during the boom, there is no substitute for owning a home on affordable terms to create middle class family security and stability.  The problem, after all, with the rise in homeowhership over the last decade from about 65 to 70% of American households was not that it happened but that it proved unsustainable.  And it proved unsustainable not because the people at the 30 to 35% level in American society do not not deserve to own a home or participate in the American Dream, but, too often, because the teaser rate mortgages offered them were deceptive, adjustable rate mortgages highly vulnerable to interest rate changes.

Since the mortgage crisis began, efforts to modify problem mortgages to make them sustainable have fallen into three categories: what might be called the good, the well intentioned, and the ugly.  The good modifications took place before TARP.  Then, banks actually changed terms--lowering interest rates and even reducing principle--as a better deal for them than foreclosure.  The labor involved in working out individual modifications, however, meant that these modifications were too few and far between to make a difference to many people. 

The well intentioned mortgage modifications were those imposed by the FDIC--and this appears to be the direction the Obama Administration is now embracing.  Under the FDIC's modification in a box, loans are modified based on borrowers' ability to pay.  However, these modifications only benefit people who have already defaulted, in effect encouraging people to default.  They do nothing to encourage home buying and largely kick the problem into the future by requiring homeowners to pay off principle reductions when they (hopefully) sell the house.  They may make sense for some problem loans the government has assumed but they will do little to address the overall housing crisis.

The ugly modifications are those that banks such as JP Morgan Chase and its Wamu subsidiary adopted after TARP.  Under one program, adopted since TARP, homeowners can swap their current mortgages for a five year one with the entire balance due in five years in a balloon payment.  This was a common mortgage in 1929 and led to millions of Americans losing their homes.  It is no better today.

In contrast to the above modifications, the 4% USA mortgage, as I am calling it, would be open to all, reduce payments for millions of Americans, and stabilize home ownership.  So why isn't everyone rallying around the idea?

It would not help everyone, for example, people who are way underwater in their homes.  However, most of those truy underwater will eventually turn in the keys. If banks want to modify these loans, then modification in a box or a one off modification may make sense.  But these are only a minority of problem loans.

The majority are those where monthly payments are unsustainable.  A simple 4% interest mortgages would help millions of Americans stay in their homes and--over time, free up a great deal of income to create new demand.

The other main objection to a 4% mortgage is it that it would increase the government's exposure to defaults through an extension of its gurantees.

The fact is the government has already guaranteed trillions in loans.  These loans, by contrast, would be comparatively safe--as who would want to default on such an attractive mortgage?  Other objections--for example that banks could not handle the volume--can be easily overcome.

Provision needs to be made to insure that banks don't push truly bad loans into the program to get trash off their books.  However, by limiting the program to a reasonable loan to value ratio and leaving it up to homeowners to elect to refinance, this problem can be overcome, and the program can still benefit millions of homeowners.

Ultimately the appeal of the 4% loan is that, like Social Security and the other most successful US government programs, it is a universal program open to all.  It does not favor those who default, who borrowed more than they could afford or indeed anyone.  And like Social Security, it should be open to everyone.

In short, this is a great benefit for the middle class that the Democrats, in order to stick to their traditional values, should embrace.  It would be a tragedy to miss this opportunity, not only to address the current housing crisis, but also to benefit American families and the American economy for many years.